Monday, July 7, 2008

Speculators = Vampires!

Some of the theories that have been bandied about regarding oil prices and speculators have reached new levels of dogma. The little poisonous gem that I happened upon was a piece that I found (via The Liberal Journal) on the Counterpunch website titled “Gas Price Gouging,” by Mike Whitney. Here’s an excerpt:

This is not about shortages or scarcity; it's about gaming the system to fatten the bottom line. The whole scam is being executed by the same carpetbagging scoundrels who engineered the subprime fiasco; the investment bankers. The Wall Street Goliaths are using the futures market to recapitalize their flagging balance sheets after sustaining huge losses in the mortgage-backed securities boondoggle. That's the whole thing in a nutshell. Now they're on to their next swindle; distorting the futures market with gargantuan leveraged bets on food and oil.

Yes, it’s the carpet-bagging investment bankers. And don’t forget the Illuminati and the Free Masons. They have a hand in everything. Here’s another zinger:

In fact, oil is being deliberately kept off the market to keep prices high. Consider this: if supply isn't keeping up with demand then why aren't there any lines at the gas stations like there were during the '70s?

Somebody needs to tell this fellow that the reason that there was rationing of gasoline and long lines to gas stations (that would then run out of gas) was due to the implementation of price controls by President Nixon. Once wholesale prices for gasoline rose beyond what a retailer could afford to buy (they had to make some profit to pay employees, taxes, utility bills, etc), gas stations ran out of gas. This meant that there was less refined gas to go around. Somehow, Mr. Whitney believes that the lack of rationing and long lines is proof that there is plenty of gas and that prices are being manipulated. The fact that prices are allowed to rise and that it is in effect a signal of the healthy elasticity of the market - there are no long lines - is proof that the mechanism of supply and demand is working as it should. Mr. Whitney does not understand basic economics.

While the futures market is a convenient scapegoat, it is simply a price discovery mechanism. Here’s one example of how the futures market works nicely: One of the reasons that Southwest Airlines has been able to be successful in recent years, while other airlines are faltering, is due to its prescient ability to lock in lower fuel prices with the futures market: It acts as a hedge against volatility and inflation. The futures market is not without risk. If a company bets incorrectly, they could lose money. It isn’t the perfectly gamed system that Mr. Whitney and others believe it is.

Note that many commodities have spiked in price over the last couple of years. It isn’t just oil. Does that mean that corn, wheat, copper, and fertilizer are being manipulated by speculators too? Should congress make laws to meddle in the trading of those commodities as well? The rise in oil is occurring globally, not just in the U.S. Attempting to stifle speculators in U.S. financial markets will do nothing to the global price of oil.

So, what’s the answer? Why has oil jumped to its record highs? The primary answers are the weak dollar and good old supply and demand, folks. I know that this is not as sexy and as attractive as a conspiracy theory. But there it is. If the Fed ever decides to fight inflation and strengthen the dollar, commodity prices would fall like a rock. It’s as simple as that. Alan Reynolds of the Cato Institute explains it best:

There is no mystery behind the rise in oil prices. They rose too high too fast because of booming demand for oil for petrochemical products, electric power and shipping from many emerging economies (particularly China, India and the Middle East). Meanwhile, the supply of oil slipped in the US, Mexico, Venezuela, Nigeria and Russia.

Now, I’m not saying that the futures and options markets have absolutely no effect on the global price of petroleum. All I’m saying is that its effect is greatly exaggerated for political reasons.

When Congress returns from vacation expect more heated rhetoric on this issue; there are currently at least ten bills submitted by Democrats attempting to address “speculation.” I blame congress for legitimizing the arguments put forth by bloggers like Mr. Whitney: No quarter is given to facts or to the unintended consequences that may follow bad legislation.


tashabud said...

Very good post. So did you leave a comment to Mr. Whitney's blog? You would have been able to point this out to him directly. Thanks for educating this non-econimist with all the technical wall Street lingo. I find it very interesting even though I'm ignorant in these topics. I didn't see your tarot's card posted.

VH said...

I didn't leave a comment with his article because there is no place to leave a post. He only has an e-mail address.

I will post my tarot card soon:)

Kevin said...

So the congress has hearings on oil specualtion? yes. Oil prices start to go down. Pipelines are blown up in Nigeria, Ossetia is attacked and Russia responds, Oil still goes down. Who do you think you are kidding with this rubbish. The speculators were pushing up the price and once the congress had hearings and are prosecuting one parasite bunch the price goes down. Can you explain this?

VH said...

Kevin, perhaps you haven’t been paying attention to the news that matters. The hearings didn’t amount to a hill of beans and the bill that would have closed the “Enron Loophole” (S3268-Stop Excessive Energy Act) failed to pass in the Senate. Why would speculators run away from making money when Congress doesn’t have any teeth? It doesn’t make any sense except to those that refuse to look at the evidence. BTW, the U.S. Commodities Futures Trading Commission released an interim report (7/22/08) that found no evidence of market manipulation by so-called "speculators." It's very simple, Kevin: As the dollar rises, commodities fall--that includes oil. Do you have ANY solid evidence (not from some analyst making a comment) from a reliable source that speculators are rigging the oil market?

Finally, why is it that people fixate on oil traders and not traders of other commodities that have skyrocketed just as high and as quickly as oil? Why isn’t Congress investigating gold traders or wheat traders? It’s because oil is an easy emotional target that will buy them votes and because gullible people will look past obvious contradictions of what is happening in order to satisfy their world view.